Critics assail watchdog’s lax oversight

The Madoff scandal is shining a new light on what critics deride as years of toothless enforcement by the Securities and Exchange Commission -- and heightening calls for major changes.

Already under fire for its regulatory performance during the financial crisis, the reputation of the federal government’s Wall Street watchdog is now in tatters after it failed to stop Bernard Madoff’s alleged Ponzi scheme before it had wiped out as much as $50 billion in investors’ money.

“The regulatory mechanism that was effective for so much of the 20th century is not relevant to the period that we’re in today,” said Arthur Levitt, who chaired the SEC from 1993 to 2001. “You need new leadership there, and you need new leadership at every level.”

Word came late Wednesday that President-elect Barack Obama is expected today to name Mary L. Schapiro to succeed Christopher Cox as SEC chief. Schapiro is chief executive of the Financial Industry Regulatory Authority, an industry group that regulates brokerages.

Cox, expressing concern that the agency missed numerous red flags about Madoff over the last decade, has asked the SEC’s inspector general to conduct an investigation.

That didn’t satisfy some SEC critics. Rep. Paul E. Kanjorski (D-Pa.), chairman of the House subcommittee that oversees the agency, called for hearings once Congress returns next month to determine why the SEC and other regulators failed to detect the alleged fraud.

The FBI arrested Madoff last week on charges of securities fraud. He was allowed to remain free Wednesday after posting a $10-million personal recognizance bond secured by his New York apartment and by properties held by his wife in Montauk, N.Y., and in Palm Beach, Fla. He was ordered to wear an electronic monitoring device and to abide by a curfew of 7 p.m. to 9 a.m.

The court gave Madoff permission to leave his home during the day for legal matters related to his case. His wife, Ruth, also had to surrender her passport.

The case took another twist Wednesday when the Justice Department said that Atty. Gen. Michael B. Mukasey had recused himself from the Madoff probe. Mukasey’s son, Mark Mukasey, is a defense lawyer representing one of the officers at Madoff’s firm.

That isn’t the only family connection of note in the case.

Madoff’s niece is married to Eric Swanson, who served as assistant director in the SEC’s Office of Compliance Inspections and Examinations before leaving the agency in 2006. The couple reportedly began dating in 2006 and married last year. An SEC official said Swanson helped conduct examinations by the agency of Madoff’s brokerage operations in 1999 and 2004, but did not participate in a 2005 exam.

In announcing the inspector general’s probe Tuesday, Cox said it should include “all staff contact and relationships with the Madoff family and firm, and their impact, if any, on decisions by staff regarding the firm.”

On Wednesday, Cox defended the agency and his record.

“We have thus far no evidence of any wrongdoing by any SEC personnel, but we’ve made it very clear that the SEC has extremely high ethical standards,” he said. “We have to recognize that when the economic tide goes out, some of the skeletons that are washed up on shore are Ponzi schemes like this one.”

The change in leadership at the SEC is an opportunity to reverse years of a failed “trust the market” philosophy permeating the agency, said Joel Seligman, an SEC historian.

Although SEC division chiefs normally don’t depart with an outgoing chairman, Seligman said the new chief should replace them.

“They desperately need new leadership now and a revitalization of their commitment to their enforcement program,” said Seligman, president of the University of Rochester.

Rep. Brad Sherman (D-Sherman Oaks) called for all five SEC commissioners to resign.

“You have a whole culture over there that needs to be changed,” said Sherman, a member of the House Financial Services Committee.

Criticism was bipartisan.

“If our nation’s top securities enforcement agency can’t uncover fraud of this magnitude, then what can they do?” asked Rep. Spencer Bachus (R-Ala.), the ranking Republican on the Financial Services Committee. “The SEC’s entire examination and inspection program is called into question.”

The Madoff scandal “is a clear failure of oversight by the SEC, and it doesn’t stand alone,” said Barbara Roper, director of investor protection for the Consumer Federation of America. “This is what government looks like when it’s entrusted to people who don’t believe in government.”

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jim.puzzanghera@latimes.com

walter.hamilton@latimes.com

Times staff writer Richard Simon contributed to this report.